Banks wary of uneven application of Basel III bank capital rules

By: David Wigan | 02 Jun 2011

As European countries prepare to introduce Basel III, concerns are mounting that its implementation will highlight a chasm between different countries in terms of bank capital levels. Is the banking sector about to see a new era of regulatory arbitrage?

“Anytime four New Yorkers get in a cab together without arguing, a bank robbery has just taken place.”

American comedian Johnny Carson’s classic joke about New Yorkers might mischievously be adapted to parody the apparent unity among European regulators following the financial crisis: even as they call for harmony, there are signs their spirit of togetherness may be short-lived.

When the Basel Committee on Banking Supervision set out its proposals for bank regulatory capital in September 2010, committee members lauded the insistence among national authorities that the rules should be applied equally across jurisdictions. Deviant financial practices must be eliminated, the battle cry sounded: all for one and one for all.

The consensus lasted one day. On the Monday following the Basel announcement, Swiss regulators indicated they would go beyond new global banking rules and instead impose stricter requirements on the country’s banks, including UBS and Credit Suisse. The so-called ‘Swiss finish’ would make local banks more competitive, said officials at Swiss financial regulator Finma and the Swiss National Bank, because the higher standard would foster a greater level of trust among investors. In any event, the regulators said, the Basel package did not go far enough to prevent a big bank’s failure dragging down the whole economy.

Switzerland was not alone in forging its own path. As the UK economy struggled to emerge from the effects of the financial crisis, with the bailouts of Lloyds Banking Group and Royal Bank of Scotland attracting negative press coverage, senior officials at the Bank of England launched increasingly acerbic attacks on the banking sector.

Leading the charge was the central bank’s governor, Mervyn King, who said he was astonished at how muted public resentment was towards banks. Meanwhile, Adair Turner, chairman of the Financial Services Authority, described some trading room activities as “socially useless”.

David Miles, an external member of the Bank of England’s monetary policy committee, published a detailed paper calling for much higher capital requirements than have been prescribed by the Basel Committee, in which he argued a doubling of capital would have a negligible impact on the cost of funding.

Where Swiss and UK regulators led the way in breaking the mould, others were quick to follow, with some northern European countries bemoaning the lack of recognition in the Basel rules for covered bonds, issued in huge volumes by their local banks. German policymakers, meanwhile, voiced concerns over the treatment of ‘silent participations’, a form of non-voting capital excluded under Basel rules.

Putting it into practice

As European vested interests pick nits in the Basel proposals, the true test of the framework has yet to come, analysts say. But the day of reckoning is not far off as national regulators begin to implement the legislation, following its incorporation into Capital Requirements Directive IV this summer.

“The implementation of Basel III into law and the new powers it gives regulators will introduce a whole new type of politics, with all the lobbying that goes along with it,” says Paul Atkinson, senior research fellow at independent economic think-tank GEM in Paris. “The Basel rules are laid down by unelected technocrats who do not operate in markets, and in Europe you have different languages and perspectives that will almost inevitably translate into a range of practices.”

If the past is any guide, it seems likely there will be plenty of room for manoeuvre for national regulators. The 2006 Capital Requirements Directive, the common framework for the implementation of Basel II, specified some 140 options and national discretions for implementation. CRD IV, which will legislate for implementation of Basel III, is likely to offer an equal amount of discretion, and perhaps more given the added level of complication compared with the previous framework. This fact has not been lost on the US Congress, where the congressional research unit last October published a report on how Basel III will work.

“The complexity of Basel III increases the probability that it would be unenforceable,” the research unit wrote. “As the Basel III framework was presented, it appeared to be as complex as Basel II that took six years to negotiate and was never fully implemented before the greatest financial crisis in 70 years began.

“The Basel Committee in Basel III tries to simplify the definition of capital to improve transparency and enforceability. The industry through its regulators, however, forced the committee to include other types of assets. By including these assets with common tangible equity, the committee adds complexity to the process of enforcement…This complexity could undermine the ability to keep the international banking playing field level.”